Five investment trends defining the first half of 2024

It has already been quite a year in financial markets. Investors came into the year expecting good things. An acceleration in global growth and company earnings alongside easing inflation and substantial interest rate cuts from central banks. As we suspected this combination proved too good to be true. Although growth and earnings have been resilient, inflation has been difficult to tame.

Against this backdrop share markets have made reasonable progress despite the headwinds of higher-for-longer interest rates and geopolitical hurdles. Yet there has been some marked differences across geographies, sectors and among individual stocks. There has also been a less rosy picture for bonds as the prospect of large and imminent rate cuts has diminished.

Here is a roundup of the main trends that have characterised the first half of the year.

Investment trends in 2024

1. Bonds lacklustre as inflation remains stubborn

As 2024 has progressed economists have had to remove their rose-tinted spectacles, admit inflation is stickier than they expected, and that interest rate cuts will be fewer and later. The turnaround in market expectations has been huge. Forecasts of six rate cuts this year in the US have given way to a conviction the Federal Reserve may cut only once as inflation has been far stickier than anticipated amid a buoyant economy and jobs market.

It is a similar picture in the UK, although the first interest cut from the Bank of England may be closer at hand. Similarly, the remaining inflationary pressures stem from wage growth feeding into services inflation, though growth is weak and economic cracks are starting to appear. The bank will therefore look to follow the lead of the European Central Bank in cutting rates, in a carefully paced manner, in coming months.

The delay to reductions in interest rates globally has acted as a brake on asset prices. That's because when interest rates are high investors can receive a higher rate of return in cash – taking no risk. Bonds have been particularly sensitive to this as they pay a predetermined and usually level return. With other investments such as shares or property, cashflows can rise to some degree in sympathy with higher inflation that usually accompanies elevated interest rates. In contrast, the fixed cash flows of bonds offer no protection as rates ratchet up.

While many parts of the bond market haven’t incurred overall losses year to date once you factor income the relatively healthy income they pay, the muted returns aren’t what many investors would have had in mind at the start of the year. Yet from this point they could provide attractive returns and a bonus of capital appreciation if interest rates do end up falling a bit more quickly than factored in, for example in the event of a sudden recession. While that is not necessarily a likely scenario it does mean bonds play a vital role in a diversified investment portfolio.

Higher for longer interest rate expectations have also spilled over into share markets with some of the weakest sector performances coming from rate-sensitive areas such as real estate and infrastructure. Meanwhile, the strong economic and corporate earnings picture has supported other parts of the market.

2. Technology giants march on

The strength in large technology-enabled US stocks has been another characteristic of the first half of the year with chip giant NVIDIA the standout stock. The company, which designs the graphics processing units essential for training Artificial Intelligence (AI) large language models, recently announced better-than-expected forward guidance. With NVIDIA selling shovels in the AI gold rush and decent results from other ‘magnificent seven’ big tech names, the narrow band of stocks that dominated returns from global indices over 2023 have largely continued to deliver for investors.

That the largest seven US companies now account for over 20% of the entire value of global stock markets is certainly pause for thought. History may tell us we should be worried about a market concentration last seen in the late nineties, immediately before the dotcom bust, but today’s conditions have little else in common with that period. This group of companies are established, highly profitable, and contain some of the potential longer-term winners from artificial intelligence or other avenues of growth. Shares are expensive in relation to their present earnings, and are vulnerable to growth falling short of expectations, but it’s hard to argue investors have lost touch with reality.

The ‘Magnificent Seven’ shares are also now showing more dispersion with one another in reaction to earnings and other news, a healthy sign that investors are not treating them as a single block. Tesla, for instance, has been a laggard. This reinforces our view that there will be both future winners and losers among this band of super-sized companies. Each has different growth drivers as well as their own fragilities and uncertainties.

The 'Magnificent Seven' are not riding off into the sunset yet

3. UK smaller companies pick up

The price for higher long-term returns from smaller companies has often been higher volatility, but in recent years there has been a more structural underperformance versus larger firms. At least until very recently.

Small caps tend to struggle in certain environments. Investors see them as being more vulnerable to rises in the cost of borrowing, so they have been more susceptible during the recent period of higher interest rates. They can also suffer when the economic environment is uncertain, particularly in the local economy in which they operate. This has been a problem in the UK where the domestic picture has been weak.

This year we have seen signs of a tentative turnaround for the widely ignored sector. In fact, the average UK smaller companies fund beat the average North American fund in the first five months of the year. The area has long been cheap but what it lacked was a catalyst to break through persistent negative sentiment and reverse investor outflows. This year some factors have combined to tentatively turn this around.

Helpfully, the performance of the UK economy has perked up a little, to the surprise of some commentators. The numbers are still not great, perhaps, but they are better than feared, which is what matters. When things seem very negative, a bit of good news goes a long way.

The green shoots of increased merger and acquisition (M&A) activity have also started appearing. The cheapness of UK shares has ushered in a series of bids for UK firms, which can create a halo effect, not just in the target business itself. It highlights to investors the cheapness of the wider market, perhaps reinvigorating the interest of those had previously dismissed it. According to Ruffer, in the first five months of this year there was over £60bn of bids for UK listed companies. This was a threefold increase activity compared to the whole of 2023, with an average bid premium (the excess over the pe-bid share price) of over 30%. As the most undervalued part of the UK market, shares in the smallest businesses have risen the most as sentiment has turned.

Looking ahead, strong operational performance across good-quality smaller companies could gradually help shine a positive light on the area. In the meantime, the M&A theme should continue, although it won’t necessarily underpin valuations across the board. Private equity buyers are often looking for specific characteristics in a company, and similarly trade buyers have certain targets for bolt on deals. The current landscape therefore favours businesses with the right combination of quality and valuation.

4. India dominates emerging market returns

Looking at emerging markets, we can see the Indian economy continues to thrive. A growing middle class is driving consumption, while shrewd government policy is helping draw international businesses to the country. India is, for instance, one of the beneficiaries of the migration of business activities from China as firms diversify their supply chains. Apple, for example, is pivoting iPhone manufacturing with ambitions to manufacture 25% of all iPhones in India by 2025, up from just 5% in 2022.

The positive economic backdrop is reflected in strong corporate results. Earnings for companies in the MSCI India rose by around 20% in 2023, and this has been a key factor in driving the stock market over the past year. However, after a strong 2023 and first half of 2024, there is concern that market prices reflect much of this growth and are vulnerable to any change in sentiment.

Briefly, it appeared that the closer-than-expected general election result might derail market buoyancy. Narendra Modi has remained as Prime Minister but has lost seats and now relies on the votes of coalition partners to secure majority. Yet despite a stronger opposition, pro-business and investment policies should be preserved. Overall, the election is unlikely to change the case for long term investment in India as a fast-growing large economy, although the expensive rating of the market does mean market volatility has to be endured.

Meanwhile, sentiment towards China is at the other end of the scale. The economic picture is partly to blame for pessimistic sentiment as growth has weakened amid weaker demand from overseas and a slowdown in consumer spending domestically. Diversification away from China-dominated supply chains has been a key factor, while an ongoing property market slump has dented the spending power and confidence of the domestic consumer.

With this going on it’s been an easy decision for investors to avoid China and look at the more reliable growth of other emerging markets such as India, even before thinking about regulatory concerns and geopolitical risks such as US tariffs on Chinese imports. Investors need to weigh up whether enticing valuations are worth it in terms of sufficient return accruing to shareholders over time.

If Chinese equities are to return to favour more convincingly, investors will need consistent and supportive policies, a stable and fair regulatory environment, and a welcoming stance towards overseas investment in Chinese companies. Suffice to say these things are not necessarily a given, which makes China higher risk and means a discount to other markets is warranted.

5. Gold shines despite higher for longer rates but mining shares lag

Despite persistent selling by Western investors over 2023 and into this year, gold has breached its previous all-time-high, and is currently trading above $2,300/oz. Central banks, investors, and households in the East have emerged as heavy buyers, notably in China as the end of the property bull market has triggered a major change in attitude towards to gold.

In many ways the renewed popularity of gold is linked to the trend of deglobalisation and heightened international tensions as central banks increasingly crave a non-politicised reserve asset. As the world continues to fragment geopolitically this trend could continue.

While gold prices have been rallying, gold equities have lagged the bullion price. As gold demand has emanated from the East and been concentrated on the physical metal, there has been no corresponding upturn in interest in the shares of gold mining companies where the natural buyers are in the West. Rising costs and, in some cases, poor operational performance has also held back returns in this higher risk sub sector. However, the longer the bullion price stays elevated the more investors will have to reconsider the undemanding valuations on offer, especially if interest rates start to decline in earnest and lessen the opportunity cost of holding gold over interest-paying cash.

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